Inflation
Inflation
Inflation is an important part of the economic environment (see Chapter 8)
because of its effect on interest rates, exchange rates, the cost of living, and
general confidence in a country's political and economic system. For example,
fear of inflation in Japan and Germany accounts for the unwillingness of
those countries to stimulate their economies in order to achieve more rapid
economic growth. The magnitude of inflation seen in many developing coun-
tries is incomprehensible to most people in the industrial world. During the
period 1980-1988, inflation increased in Argentina by 290.5 percent, in Bra-
zil by 188.7 percent, in Bolivia by 482.8 percent, in Peru by 119.1 percent,
and in Israel by 136.6 percent.20 By the end of the 1980s, inflation in Brazil
was 1000 percent per annum.
In highly inflationary environments, it is difficult for firms to plan for the
future and run profitable operations. Companies must change prices almost
daily in order to maintain a sufficient cash flow to replace inventory and keep
the firm operating. Accurately forecasting inflation is difficult, so firms end
up underpricing or overpricing products, which results in a shortage of cash
flow or a price that is too high to maintain market share.
Inflation of the magnitude seen in Bolivia, Argentina, or Brazil also cre-
ates problems for firms that deal in international markets. If the exchange
rate depreciates at the same pace as inflation, then the prices that foreigners
pay for exports of the inflationary country will not really change. But if the
exchange rate does not change as much as inflation is forcing companies to
raise their prices, the local companies will soon find that they cannot compete
in world markets.
Inflation causes political destabilization. If the government tries to con-
trol it by controlling wages, the real income of the population declines and
frustration sets in. If the government decides to do nothing, the country risks
having the economy deteriorate to the point that real incomes fall anyway.
To institute fiscal rigor when the government is in a fragile position in the
first place is very difficult
Inflation is an important part of the economic environment (see Chapter 8)
because of its effect on interest rates, exchange rates, the cost of living, and
general confidence in a country's political and economic system. For example,
fear of inflation in Japan and Germany accounts for the unwillingness of
those countries to stimulate their economies in order to achieve more rapid
economic growth. The magnitude of inflation seen in many developing coun-
tries is incomprehensible to most people in the industrial world. During the
period 1980-1988, inflation increased in Argentina by 290.5 percent, in Bra-
zil by 188.7 percent, in Bolivia by 482.8 percent, in Peru by 119.1 percent,
and in Israel by 136.6 percent.20 By the end of the 1980s, inflation in Brazil
was 1000 percent per annum.
In highly inflationary environments, it is difficult for firms to plan for the
future and run profitable operations. Companies must change prices almost
daily in order to maintain a sufficient cash flow to replace inventory and keep
the firm operating. Accurately forecasting inflation is difficult, so firms end
up underpricing or overpricing products, which results in a shortage of cash
flow or a price that is too high to maintain market share.
Inflation of the magnitude seen in Bolivia, Argentina, or Brazil also cre-
ates problems for firms that deal in international markets. If the exchange
rate depreciates at the same pace as inflation, then the prices that foreigners
pay for exports of the inflationary country will not really change. But if the
exchange rate does not change as much as inflation is forcing companies to
raise their prices, the local companies will soon find that they cannot compete
in world markets.
Inflation causes political destabilization. If the government tries to con-
trol it by controlling wages, the real income of the population declines and
frustration sets in. If the government decides to do nothing, the country risks
having the economy deteriorate to the point that real incomes fall anyway.
To institute fiscal rigor when the government is in a fragile position in the
first place is very difficult
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